On April 11, 2012, the Court of Chancery of Delaware denied defendants’ motion to dismiss plaintiffs’ claims. The plaintiffs consisted of the shareholders of the Answers Corporation (“the company”), who alleged that the board breached its fiduciary duties of care, loyalty, and good faith in connection with the merger of the company with AFCV Holdings, LLC (“AFCV”). The plaintiffs further alleged that A-Team, a wholly owned subsidiary of AFCV, which is a portfolio company of Summit Partners, L.P. (collectively, “the Buyout Group”), aided and abetted the company’s breach of its fiduciary duties. In re Answers Corp. Shareholders Litig., C.A. No. 6170-VCN (Del. Ch. Apr. 11, 2012).
The plaintiffs specifically asserted that three conflicted board members conducted the sales process in accordance with their own interests and accepted an unfair price for the company. With respect to the other board members, the plaintiffs claimed they knowingly allowed this flawed sales process to occur and therefore breached their duty of loyalty. The plaintiffs alleged that the board locked up the merger with unreasonable deal protection measures, used the merger to gain benefits for itself, and issued materially misleading proxy materials.
According to the complaint, Redpoint Ventures (“Redpoint”) owned 30% of the stock at the time of the merger, was the largest shareholder of the company, and wanted to sell its interest. The plaintiffs asserted that Redpoint threatened Mr. Rosenchein, the company’s CEO, that the entire management team would be replaced if it did not find a way to sell the company. Further, two other board members appointed by Redpoint, W. Allen Beasley and R. Thomas Dyal, steered the sale to benefit Redpoint’s goal.
The plaintiffs’ complaint alleged that in November 2010, AFCV offered to buy the company for $10.25 per share, which was more than the trading price at the time. However, negotiations continued and by December, the board became concerned that the company stock was going to rise above ACFV’s offer price unless the sale occurred quickly. The plaintiffs alleged that the board was aware of Redpoint’s goal and approved a quick sales process to guarantee that the company stock would not rise above $10.25 per share before the sale.
The plaintiffs’ complaint further alleged that the Buyout Group insisted that the board do a quick “market check.” In response, the board asked UBS, its financial advisor, to do a two-week market check, which UBS stated was not a “real” market check. It coincided with the holidays and was not an accurate representation of the interest in the company. In April of 2011, the board received an offer from Brad. D. Greenspan to buy a controlling interest in the company at $13.50 per share. The board rejected the offer, stating that it was not superior to the ACFV offer.
The defendants denied the allegations and moved to dismiss the claims. The board argued that the plaintiffs had failed to state a claim for any breach of fiduciary duty. The Buyout Group alleged that since the plaintiffs failed to state the underlying claim, they also failed to state a claim for aiding and abetting, among other arguments.
When a board decides to sell a company, “the board must perform its fiduciary duties in the service of a specific objective: maximizing the sale price of the enterprise.” There is no one specific way to meet this requirement, but the process the directors follow must be reasonable. The board must consider the option of keeping the company independent, it cannot manipulate the sales process in any way to benefit a particular bidder, and it must seek the highest reasonable value available for its shareholders in the case it decides to sell.
To plead that a board breached its duty of loyalty, the plaintiff must allege facts that “the majority of the board either was interested in the sales process or acted in bad faith in conducting the sales process.” An interested director is one who receives a personal financial benefit that the other directors do not. Further, to show a director acted in bad faith, the plaintiff must show the director “intentionally fail[ed] to act in the face of a known duty to act, demonstrating a conscious disregard for his or her duties.”
The court held that the plaintiffs adequately pled the board breached its fiduciary duty for the following reasons: (1) the CEO knew his job was on the line if the sale did not go through and actively attempted to sell the company before the stock price went up; (2) two other directors manipulated the sale “to achieve liquidity for Redpoint”; and (3) the rest of the board was aware of the reasoning behind the sale and allowed the flawed sales process to proceed. In addition, the court held that while there was nothing inherently unreasonable about the deal protection measures and the board extracting certain benefits like accelerated stock options, these issues were tag-along claims to the breach of fiduciary duty, and therefore should not be dismissed at this time.
To plead aiding and abetting of a breach of fiduciary duty, the plaintiffs must show (1) that a fiduciary relationship existed, (2) there was a breach of that duty, (3) the defendants knowingly participated in the breach, and (4) the plaintiff suffered damages caused by the breach.
Since the plaintiffs sufficiently pled breach of fiduciary duty, the court held that they satisfied elements 1, 2, and 4. The court decided that the plaintiffs had satisfied element 3 as well, because the Buyout Group had non-public information about the company that it used to push the board to do a quick market check and close the sales process before the stock price could rise above ACFV’s offer price.
Therefore, because the plaintiffs adequately pled breach of fiduciary duty and aiding and abetting of that breach, the court denied both motions to dismiss. However, the court did dismiss the plaintiffs’ proxy claim because the plaintiffs had abandoned that claim.
The primary materials for this case may be found on the DU Corporate Governance website.